Should foreign investors be concerned about the new National Security Review measures in China?
In this blog post, we share our practical experience over the past year in helping clients navigate through the new Chinese National Security Review (NSR) regime.
What is clear and unclear regarding which sectors are caught by the New NSR regime in China?
According to the Measures for Security Review of Foreign Investment which became effective from 18 January 2021 ("Measures"), foreign investments into two categories of sectors will require NSR clearance in China:
The first category does not require investments to confer control upon foreign investors. This category comprises exhaustively investments in sectors which concern security of national defence, such as the military industry and military industrial support, and investments in locations that are geographically within the proximity of military facilities and military industrial facilities.
In practice, we have not come across transactions which involve foreign investors' investments into military related sectors in China.
The second category requires investments to confer at least de facto control upon foreign investors. This category includes investments into the following list of sectors which are considered to concern national security:
- Important agricultural products;
- Important energy and resources;
- Important equipment manufacturing;
- Important infrastructure;
- Important transport services;
- Important cultural products and services;
- Important information technology (IT) and Internet products and services;
- Important financial services;
- Key technologies; and
- Other important sectors.
In practice, we have been frequently consulted to confirm whether a transaction may be caught sector-wise by the Measures. In this regard, we have the following observations, based on our experience:
- It is not provided under the Measures as to what amounts to "important" or "key". This leaves the authority (National Development and Reform Commission, "NDRC") with considerable discretion, and a relative broad interpretation appears likely. Therefore, in practice we have been inclined to consider the invested sectors as in-scope if they appear close to the description provided by the Measures.
- IT, Internet and technologies have come into the limelight due to the rise of digital economy, artificial intelligence, big data, powerful tech companies as a global trend. In practice, foreign investors should not underestimate the strategic importance and sensitivity of these sectors when assessing the relevance of Chinese NSR regime to a particular transaction.
- The second category contrasts with the first category in two crucial aspects: (i) foreign investments into the second category of sectors would only be caught when they confer at least de facto control over foreign investors, which is elaborated in the following section; and (ii) the sectors listed in the second category are non-exhaustive, given the catch-all clause.
Is the control definition under NSR regime broader than the control definition under antitrust regime?
As we often assess whether an NSR filing is required as part of the global antitrust/FDI filing analysis for a given transaction, we have come across internal and external queries as to whether the control test under the NSR regime is similar to that under the antitrust regime. This is in particular important for minority investments.
Under the NSR regime, the Measures provide that, for minority investments, de facto control would arise if (i) the voting rights enjoyed by a foreign investor allow it to exert material influence over the board of directors, shareholders' meetings, or resolutions of shareholders' meetings; or (ii) there are other circumstances that would enable foreign investors to exert material influence over management decision-making, human resources, finance, technology, etc.
Under the antitrust regime, despite no detailed guidance, relevant law provides that control has a similar meaning to decisive influence and the factors to take into account in control assessment typically include the ability to veto decisions relating to the business plan, senior management hiring and firing and board composition, taking into account voting mechanisms and historical attendance and voting patterns at shareholders' meetings.
In view of the above, while there is no official clarity on this point yet, many practitioners hold the view that the control threshold under the NSR regime is lower than that under the antitrust regime in China. In other words, the NSR regime's control has a broader catch than control within the meaning of antitrust rules.
This suggests that the absence of control under antitrust rules does not necessarily mean the lack of de facto control under the NSR regime. To be prudent, in practice we would recommend separate control analysis conducted along with the antitrust control analysis.
What is the advisable approach to foreign investors' "indirect" (offshore or foreign-to-foreign) investments in China?
Over the past year, most of the NSR-related queries we received concern foreign investors' offshore transactions relating to China.
Subjecting indirect investments to the NSR regime marks an expansion of jurisdiction, as indirect investments were not caught by the previous NSR rules which came into force in China in 2011.
Nevertheless, in practice we have not encouraged clients to file offshore deals with NDRC on NSR grounds, mainly for considerations that (i) offshore deals concern transfer of ownership in Chinese enterprises/assets that are already under foreign ownership, so there are no "traditional" national security concerns unless the identity of the new foreign investor itself has national security sensitivity; and (ii) there are no penalties for failure to file under the Measures. Moreover, NDRC, after identifying a failure to file, would give the foreign investor in question an opportunity to make a filing, and NDRC would only take measures to restore the pre-transaction status when the investor still refuses to file after prompted by NDRC.
Our recommendation to foreign investors
It is obvious that many provisions in the Measures (such as the scope of caught sectors, the meaning of de facto control, timing to submit filing, etc.) call for clarification and detailed rules to guide its further implementation in China.
Nevertheless, the Measures also provide procedural convenience to assuage possible uncertainties arising from the their vagueness. Firstly, the Measures provide that all filings shall go through a preliminary screening review stage to let NDRC determine whether transactions merit review on national security grounds. Such preliminary review is up to 15 business days. Secondly, if investors wish to seek full legal certainty on notifiability, NDRC is open to accept consultation requests. Unofficial sources indicate that NDRC has responded to consultation requests in a timely manner over the past year.
In summary, the new NSR regime in China in general is not meant to be more interventionist than foreign investment control regimes in other jurisdictions. We consider that there are no indications to suggest that foreign investors should be concerned about the new Chinese NSR regime. But separate NSR analysis should always be conducted in transactions which involve foreign investments in China.